GTCR doubles dose in health care

Firm ramps up investments despite questions over reform

Obamacare or no Obamacare, GTCR sees money to be made in the health care industry.

GTCR LLC, the city's second-biggest private-equity firm, which has invested about $8 billion since its inception in 1980, this year made three health care acquisitions and launched two partnerships to buy more companies in the industry. That's more health care deals than it's had in any one of the past four years, though it declines to disclose values.

The deal-making reflects a bet that demand for health-related products and services will keep growing, but it also makes the firm dependent on the sector amid growing uncertainty as the Obama administration's Patient Protection and Affordable Care Act takes effect and Republicans try to roll it back.

“Demand for (health care) services and products is going to continue to increase” as people live longer and more are covered by health insurance, says GTCR partner David Katz, co-head of the firm's health care group with partner Dean Mihas. “What isn't clear is how exactly the various sectors are going to benefit from that growth and to what degree various sectors are going to benefit from that growth.”

The firm scattered its investments this year across sectors ranging from diagnostic tools to physical therapy clinics to pharmaceuticals and health care claims management.

Mr. Katz says GTCR isn't new to health care, an industry where it has long invested up to a third of its capital. It also focuses on financial services and technology, each of which represents about a third of the firm's investments.

GTCR's health care acquisitions this year outpaced those of Chicago-based Linden LLC and Water Street Healthcare Partners LLC, which exclusively target the industry. Another Chicago private-equity firm, Roundtable Healthcare Management Inc., did six deals. Madison Dearborn Partners LLC, the biggest local private-equity firm, didn't make any in this sector this year.

Private-equity health care acquisitions have more than doubled, to $10.7 billion, so far this year, from about $5.26 billion last year, according to Seattle-based PitchBook Data Inc.

More private-equity firms are investing in health care because it's a big industry—accounting for about 18% of the gross domestic product—that is fragmented and has a lot of potential for growth, retired Water Street co-founder Kip Kirkpatrick says. Health care spending in the U.S. will rise 5.1% this year to $2.6 trillion, climbing faster than U.S. economic growth of 4%, according to federal government projections.

“There are not many industries in the U.S. right now where you have the wind at your back like you do in health care,” he says.

While Roundtable did “significantly more” health care acquisitions this year than last, it has been cautious about what the right investment niches are, says Co-Chairman Lester Knight, whose firm this year invested in a sleep and respiratory diagnostic products company and a surgical blades and scalpel products business, among others.

“You have to be careful,” Mr. Knight says. “We're very worried about the service areas and the cuts to services that could be coming, so we typically don't get involved in the service areas.”

Messrs. Katz, Knight and Kirkpatrick expect the federal government to cut Medicare and Medicaid reimbursement rates for some services and pharmaceuticals as it moves toward a more efficient payment model. Such cutbacks could curtail revenue growth at any or all of the companies GTCR and other private-equity firms have invested in.

Private insurers will follow the government's lead in cutting payment rates, although they will also increase spending on technology, predicts William Blair & Co. health care analyst Corey Tobin in Chicago. He doubts GOP threats will affect the rollout of the new law.

William Atwood, who leads the Illinois State Board of Investment and has invested the state employee pension fund's money with GTCR, calls health care investing a smart, “recession-resistant” wager in a tough economy. He says the board's investments with GTCR have generated annual returns of 17.2% since 1984.

“Part of the attractiveness, even given the regulatory environment, is health care companies are able to pass through costs and raise their prices, whereas in other sectors you can't,” Mr. Atwood says.